On December 2, 2008, the IRS issued Notice 2008-111, which provides guidance on transactions it considers intermediary transaction tax shelters. The Service issued the notice to help clarify which transactions are considered intermediary transactions and who is considered a participant in an intermediary transaction. Notice 2008-111 clarifies Notice 2001-16 and supersedes Notice 2008-20.
What Is an Intermediary Transaction?
A common intermediary transaction involves a seller (Seller) who wants to sell the stock of a corporation (Target) and a buyer (Buyer) who wants to purchase assets (and not the stock) of Target. Under a plan, Seller sells the Target stock to an intermediary corporation (Midco). Midco then sells some or all of Target’s assets to Buyer. Because of the asset sale, Buyer will have a basis in the assets equal to the fair market value of the assets. Typically, Midco either is an entity not subject to tax or has certain tax attributes that it believes would somehow offset any tax impact of the asset sale.
Previous IRS Guidance
Initially, the IRS issued Notice 2001- 16, which identified these intermediary transactions as tax shelters. The notice stated that any transaction that is the same or substantially similar to the intermediary transaction as described in the notice is considered a listed transaction and would be subject to the necessary reporting requirements. The notice also warns of potential penalties that may result from participating in these transactions or from either promoting or reporting these transactions as a tax return preparer or a representative of an intermediary transaction participant.
Because Notice 2001-16 applies to transactions that are “the same or substantially similar to” an intermediary transaction as described in the notice, many practitioners wanted more guidance on what constitutes an intermediary transaction. Accordingly, the Service issued Notice 2008-20 on January 17, 2008. The notice identified four objective components of an intermediary transaction. All four components were necessary in order to meet the standard of “the same or substantially similar to” an intermediary transaction. As discussed below, these objective components identified by Notice 2008-20 have been superseded by four modified components in Notice 2008-111.
Notice 2008-20 also created a pair of safe harbors for potential participants in an intermediary transaction. Under Notice 2008-20, if a potential participant meets the requirements of either of these safe harbors, the potential participant would not be considered a party to the intermediary transaction identified in Notice 2001-16. Notice 2008-111 also supersedes and modifies these safe harbors, as described in detail below.
Under Notice 2008-111, a transaction constitutes an intermediary transaction with respect to a particular person if:
- The transaction occurs under a plan and the person engages in the transaction under that plan;
- The planned transaction meets four objective components indicative of an intermediary transaction; and
- No safe harbors apply to that person.
Under Notice 2008-111, a plan is described as a transaction, in connection with the disposition by Target shareholders of all or a controlling interest in Target’s stock, structured to cause the tax obligation for the taxable disposition of Target’s built-in gain assets to arise under circumstances in which the person or persons primarily liable for any income tax on the disposition will not pay that tax. A person engages in the transaction under a plan if the person knows, or has reason to know, that the transaction is structured to effectuate the plan. If the seller is at least a 5% shareholder of Target or is an officer or director of Target, then the seller will be deemed to have “reason to know” if any of the following situations exist:
- An officer or director of Target knows (or has reason to know) about the plan to effectuate the transaction. If there are more than five officers or directors of Target, the term “officer” will be limited to the CEO and the four highest compensated officers;
- An adviser engaged by Target to advise Target or Seller on the transaction knows (or has reason to know) of the plan to effectuate the transaction; or
- An adviser engaged by Seller to advise on the transaction knows (or has reason to know) of the plan to effectuate the transaction.
The notice warns that a person can “engage” in the transaction under a plan even if the person does not understand the mechanics of the transaction or the relationships of the parties or of Target after the disposition. A transaction could be an intermediary transaction for the seller and not the buyer, for the buyer and not the seller, or, if there is more than one seller or buyer, for some buyers or sellers and not other buyers or sellers, depending on whether the parties acted under a plan. A transaction can be under a plan regardless of the ordering of the asset sale and stock disposition.
Even if a taxpayer engages in a transaction under a plan, it is an intermediary transaction only if the transaction meets all four objective components set forth by Notice 2008-111:
- Target corporation directly or indirectly owns assets with a built-in gain (fair market value exceeds the tax basis of the assets) and, at the time of the transaction, Target (or the consolidated group of which Target is a member) has insufficient tax benefits to eliminate or offset the gain (or tax) on the sale of the assets in whole. The tax that would have resulted from an asset sale is referred to as Target’s built-in tax. However, for purposes of this component, Target will not be considered to have any built-in tax if the tax is less than 5% of the value of the Target stock disposed of in the transaction.
- Target shareholders dispose of at least 80% (by vote or value) of the Target stock, other than in a liquidation of Target, in one or more related transactions within 12 months of the transaction. The first date on which at least 80% of the target stock has been disposed of by Seller is the “stock disposition date.”
- Either within 12 months before, simultaneously, or within 12 months after the stock disposition date, at least 65% (by value) of Target’s built-in gain assets are disposed of to one or more unrelated buyers in a transaction or transactions in which gain is recognized on the asset sale.
- At least half of Target’s built-in tax that would otherwise result from the disposition of the assets sold is purportedly offset, avoided, or not paid.
If the person engaged in the transaction under a plan and the four components of an intermediary transaction are met, the person will nonetheless not be considered to have a reporting obligation under Notice 2008-111 if the person falls under one of the following safe harbors:
- The person is a seller of Target stock that is traded on an established securities market and, prior to the disposition, the seller did not hold 5% or more by vote or value of any class of Target stock disposed of by the seller;
- The person is a seller, a target, or a midco if, after the acquisition of the target stock, the buyer of the Target stock is the issuer of stock or securities that are publicly traded on an established securities market in the United States or is consolidated for financial purposes with such an issuer; or
- The person is a buyer of Target assets, and the only Target assets it acquires are either securities that are traded on an established market and represent a less-than-5% interest in that class of security or assets that are not considered to be trade or business assets.
Effective Date for Notice 2008-111
Because this notice is a clarification of intermediary transactions subject to Notice 2001-16, this notice is generally effective January 19, 2001, when Notice 2001-16 was initially effective.
Potential Consequences for Failure to Comply with Notice 2008-111
Persons who are required to disclose these transactions and fail to do so may be subject to a penalty up to $200,000 (Sec. 6707A). A person required to disclose or register these transactions as a material adviser under Sec. 6111 who has failed to do so may be subject to penalties up to $200,000 or 75% of the income derived from advising on the transaction, if greater (Sec. 6707(b)). In addition, in the case of an SEC registrant corporation, a person must disclose any payment of a penalty with respect to a listed transaction in his or her public filing for that period. A person required to maintain lists of investors as material advisers who fails to provide these lists within 20 days of an IRS request may be subject to penalties up to $10,000 per day until the list is provided (Sec. 6708).
Other accuracy-related penalties may also be imposed on persons involved in these intermediary transactions or on persons who participate in the promotion or reporting of these transactions (including the return preparer penalty, the promoter penalty, and the aiding and abetting penalty). The potential accuracy-related penalties imposed on persons involved in these transactions can result in an additional 40% added to the amount of tax underpaid and/or an additional 30% on the amount of the understatement of income multiplied by the highest applicable tax rate. The adviser penalties can range anywhere from $1,000 to up to 100% of the income derived from advising on these transactions. Further, the statute of limitation may be extended beyond the typical three-year period for persons who are required to disclose these transactions and fail to do so.
Potential State Tax Consequences
Several states (e.g., California, Illinois, and New York) have implemented reporting and disclosure requirements similar to federal rules for certain transactions of interest, as well as list maintenance requirements. Failure to comply with the necessary state requirements may result in additional penalties.
Jeff Kummer is director of tax policy at Deloitte Tax LLP in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.
For additional information about these items, contact Mr. Kummer at (202) 220-2148 or firstname.lastname@example.org.